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Leasing a Car: 8 Terms You Should Know

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author photo by Doug DeMuro October 2014

Leasing a car can be a complicated process, especially if you've never done it before and you're not exactly sure how it works. If that sounds like you, then you've come to the right place. We've put together a list of eight important terms you might read or hear during the leasing process, and we've defined each one in simple, easy-to-understand language to give you an advantage before you ever set foot in a car dealership.

Acquisition Fee

An acquisition fee, sometimes called the "bank fee," is the amount of money charged by a bank or an automaker for processing a new lease. Typically ranging from $500 to $1,000, the acquisition fee is similar to a car's destination charge in the sense that it can rarely, if ever, be negotiated. However, some automakers or banks will roll the acquisition fee into a car's monthly payments, which allows you to spread out the cost over time. If the acquisition fee isn't rolled into monthly payments, you'll have to pay it up front, even on leases that advertise no down payment at signing.

Capitalization Cost

Although capitalization cost sounds a little intimidating, it's merely the price of the vehicle. If you were buying the car, the term "capitalization cost" would instead be "purchase price," which sounds a lot simpler. A more complicated term is "cap cost reduction," or "capitalization cost reduction," which is also a common leasing phrase. This is used to refer to any amount of money that lowers the overall price of the car, such as a down payment. For instance, if a car costs $24,000 and you put down $2,000 up front, then the capitalization cost is $22,000, thanks to a cap cost reduction of $2,000. Any cap cost reduction will serve to lower your monthly payments because it lowers the amount you'll have to pay over the lease term.

Disposition Fee

Many leasing companies and automakers charge a disposition fee, which is assessed at the end of the lease. These fees, which typically range from $350 to $550, cover any costs associated with the return of the car, including washing it, dealing with paperwork and preparing it for future sale. Drivers who purchase the leased car at the end of a lease will not be assessed a disposition fee because the dealer will not need to prepare the car for sale.

Down Payment

A down payment in the leasing world works very much like a down payment in the world of traditional car financing. In essence, a down payment is an initial payment on the vehicle before you have to make any monthly payments. For example, if a dealership asks you to pay $2,000 before you can lease a $24,000 car, that $2,000 is the down payment on the car. It means you only owe lease payments on the vehicle's remaining $22,000 price. While many shoppers don't like the idea of putting down large amounts of money, down payments can be beneficial; they lower your monthly payment by reducing the overall amount you have left to pay.

Gap Insurance

If your car is in a serious accident and is totaled while you lease it, your insurance company will cover the value of the car. If you owe more on your lease contract than the car is worth, you'll be stuck with the bill for the leftover amount. The solution is gap insurance, which helps to cover any financial difference between the lease contract and the vehicle's actual value. While some people suggest avoiding gap insurance because there's a slim chance that you'll need it, drivers who owe significantly more on their car than it's worth may want to consider it. Otherwise, you could face a big bill after a major accident.

Money Factor

The money factor, which is sometimes called the lease factor, is the rate you'll pay in finance charges during each month of your lease. This rate is set by an automaker or bank, and it can be increased or decreased to keep up with demand or change profit levels. For example, an automaker or bank that wants more people to lease a car may decrease the money factor, which lowers the finance charges and drops the monthly payment. Although some salespeople mistakenly quote this as the interest rate, the two are different -- and you must multiply your money factor by 2,400 in order to calculate your interest rate. For instance, a money factor of 0.0025 translates to a 6 percent interest rate.

Residual Value

Residual value is the predicted amount of money that your car will be worth when the lease ends. For example, if you lease a $25,000 car today, the 36-month residual might be around $17,500. That $17,500 is the amount that the bank or the automaker thinks the car will be worth at the end of a 3-year lease. It's also the amount of money that your lease payment is based on, which is why cars that benefit from a high residual value tend to have lower payments than vehicles that depreciate more rapidly.

Security Deposit

Just like leasing an apartment or a house, leasing a car often requires a security deposit. This money, typically equal to about 1 month's payment, guards against any damage to the vehicle during the lease. It's also refundable if there aren't any damages when you turn in the vehicle. For instance, if your security deposit is $1,000 and you turn in the car with dents and scratches that cost about $400 to fix, you'll get about $600 back from the leasing company after the repairs have been performed. If you return the car with no damage, you will get back the entire $1,000 security deposit.

This image is a stock photo and is not an exact representation of any vehicle offered for sale. Advertised vehicles of this model may have styling, trim levels, colors and optional equipment that differ from the stock photo.
Leasing a Car: 8 Terms You Should Know - Autotrader